For Compliant Advisors, Known (and Unknowable) Unknowns

The SEC, FINRA, DOL regulations and oversight come from all sides, and anticipating what's compliant today but won't be tomorrow is a tricky game.

By Melanie Waddell|September 28, 2015 at 08:00 PM

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Keeping up with changing compliance rules is a daily burden for advisors. (Illustration: Jon Krause/The Ispot.com)

Keeping up with new rules — as well as old ones that just won’t go away — has become the bane of advisors’ and broker-dealers’ existence, with compliance and legal experts able to easily tick off a list of rules and laws that have been handed down over the years that drive them, well, berserk.

Lawmakers, as well as the myriad regulatory bodies like the Securities and Exchange Commission, the Financial Industry Regulatory Authority, the Department of Labor and the current presidential administration, are the culprits in creating an endless compliance chore list for advisors and BDs.

However, there are rules that industry officials argue are and will continue to be sorely needed to keep scams and other types of harm to investors at bay. Officials even cite the negative repercussions brought on by “rejected rules” that continue to plague the industry.

Jon Henschen, owner of the broker-dealer recruiting firm Henschen & Associates, likens the current regulatory environment to sentiments expressed by writer and theologian C.S. Lewis: “Those who torment us for our good will torment us without end.”

Fiduciary rules by DOL and the SEC — if they’re coming — rank high among regs that advisors and BDs should be watching as well as potential legislation to boost the number of advisor exams. But long-established rules that have faced changes over the years, like the SEC’s custody rule and its chief compliance officer rule issued back in 2004, rank high in importance as well.

Regulatory Milestones

While this year marks the 75th anniversaries of the Investment Company Act and the Investment Adviser Act, arguably two of the oldest rules that have stood the test of time, the impact of other more recent — as well as upcoming — rules have yet to be fully felt. Case in point: the DOL’s controversial rule to amend the definition of fiduciary under the 40-year-old Employee Retirement Income Security Act.

Brian Hamburger, CEO of MarketCounsel, opines that DOL’s rule will not have a “big impact” on investment advisors directly (broker-dealers, on the other hand, may feel the biggest brunt), and says that even if DOL issues a final rule, it won’t happen for “a while.”

Labor has said it wants a final fiduciary rule on the books by May 2016, but Hamburger argues it will be “incomplete regulation” without an SEC rule.

The “big question mark” that remains, Hamburger says, is, “will the SEC get involved” and issue its own fiduciary rule? “Will they finally take on their role?” he asks. “Everything that DOL is doing is really an effort to get around the fact that the SEC is not engaged in the [fiduciary] rulemaking that it should” under the authority given to the agency by Section 913 of the Dodd-Frank Wall Street Reform and Consumer Protection Act.

Hamburger argues that if the SEC had stepped up to the plate and enforced the Merrill Lynch Rule’s “solely incidental exemption,” the fiduciary quandary of today would not exist. “This rejected regulation and the [SEC's] lax interpretation of the term ‘solely incidental’ has really been the impetus for all of the confusion that’s become the rallying cry for a uniform fiduciary duty,” Hamburger says. “If the SEC had drawn the line and said, ‘No, broker-dealers, if you want to act as an advisor, you have to register as one,’ would we be where we are today? The answer is almost certainly no.”

Indeed, Dodd-Frank also celebrated a birthday this July. Five years ago, President Barack Obama signed the watershed financial reform legislation into law. It was also five years ago that DOL scrapped the original version of its fiduciary rulemaking due to fierce backlash from lawmakers, as well as the broker-dealer and insurance industries, and started again. The controversial redraft that’s still enduring a drubbing today has been five years in the making.

Duane Thompson, senior policy analyst at fi360, wonders if the “playing field” for investment advice will ever be level. “Investment advisors have been playing defense for decades while brokers and product sellers have adopted their business model but fought against the same high [fiduciary] standards,” he says. Dodd-Frank “gives the SEC authority to impose a level playing field by adopting a uniform fiduciary standard for retail advice by brokers and advisors, and the DOL’s rule of expanding the ERISA fiduciary standard would essentially do the same thing on the pension side.”

Adds Thompson: “These [fiduciary rules] are big stories, and will have a direct impact on all advice-givers, but right now we’re only in the fifth or sixth inning until the DOL and SEC adopt new rules.”

SEC Chairwoman Mary Jo White has stated publicly that she’s for developing a fiduciary rule that would be codified, principles-based and rooted in the Investment Adviser Act rule. But the fact that the SEC is losing two commissioners soon — one Democrat and one Republican — throws further doubt into how quickly the agency could move on its own fiduciary rulemaking.

Dodd-Frank also helped to launch the SEC’s drive to reduce risk in investment products, Thompson notes, namely money market and target-date funds, as well as the agency’s pending rule that advisors must disclose alternative investments on their Forms ADV.

The Investment Adviser Association has urged the SEC to focus a “particularly keen eye” on the disproportionate costs that would be imposed on smaller advisors if the agency moves ahead with its plan to require advisors to provide more data on separately managed accounts on their Form ADV. The agency also wants advisors to disclose more information on their social media use as well as their branch offices.

Broker-dealer recruiter Henschen argues that Dodd-Frank has been used to “weaponize” regulation. “Regulation in the past was meant as guidance to consult with management in how to do things in proper fashion in order to run efficiently and correctly,” he says. “Regulation is now used as a fine generator to make FINRA profitable and ever larger.”

FINRA’s tracking of reps’ “business, emails, outside business activities, etc., is adding considerable expense to compliance departments so the smaller BDs — especially the thousands of one- to 10-man shops — will be under increasing profitability constraints,” Henschen argues.

The SEC and the CCO

CCO liability for advisory firms is another area of concern, notes Hamburger. “If you watch the enforcement actions, the SEC has taken a much stronger position against CCOs while publicly saying that they don’t want to go after CCOs,” he says. This heightened scrutiny on CCOs has “made filling that role very difficult.”

Reluctance to take on the CCO role will put the onus for compliance on the firm founder or “one of the original heads of the firm,” Hamburger adds, which is “going to limit the growth of advisory firms.” CCO liability can’t be given “short shrift; it’s going to need attention.”

What didn’t need attention, however, in some industry experts’ eyes are the recently issued rules by the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) regarding anti-money laundering for advisors.

Hamburger argues the AML rules will be a “frustrating and downright infuriating exercise for the vast majority” of independent advisors. Tom Giachetti, chair of the Securities Practice Group at Stark & Stark, agrees the rules are “overkill.”

“Advisors can’t provide their services without the use of a financial institution that’s already subject to AML regulation,” Hamburger says, so “there’s really no benefit here to adding yet another layer of duplicative regulations with AML rules.”

Giachetti agrees that advisors continue to be “indirectly subject” to AML rules, “as previously recognized by FinCEN in 2007 when it reconfirmed that SEC advisors were not required to adopt and maintain an AML program because the AML exercise is already undertaken by the independent custodian before an advisory account can be opened.”

Another important point to remember, he says, is that requiring advisors to adopt a formal AML program “ignores the fact that virtually every small to medium-sized advisor in the country does not have, and never will have, any clients who may have any association at all (direct or indirect) to anyone on the Office of Foreign Assets Control’s sanctions lists.”

FinCEN “had it right” in 2007, Giachetti says, when it stated that qualified custodians should maintain a formal AML program.

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